I doubt whether there has ever been a bigger gap between what insurers think you should buy and what consumers actually buy. This is the size of the disconnect: One insurer’s life cover calculator quickly gets the recommended cover amount over $1.5 million, yet $500,000 is what most advisers start quoting, and consumers typically buy $200,000, usually from their bank.
The difference in methodology is astonishing.
Usually lump sum benefits are easy to assess: how much to pay off debt, create an emergency fund, and pay for the funeral – all numbers that can easily be suggested by the insurer, or supplied by the consumer, then add them up. The trick comes to ‘other’ things, the leading category appears to be funding the children’s education. This is an emotive subject, and therefore ideal for discussion around the risk of early death. What better to leave your children than the gift of a good education? A shared goal of many parents is to see their children safely through a degree with no student debt. Do that and few people could say you have failed. Another leading contender is funding retirement for the survivor – leave your partner set up for retirement must surely rate as another worthy goal. So the calculators invite you to add all that up. It quickly gets expensive. Then the calculators invite you to work out how much income you would like to replace, for how long.
There are problems with this approach are more in what it does not do, that what it does:
- It nearly always places life cover first as the main need, yet disablement is far more likely than early death, and in many cases more financially damaging.
- Since a third of income typically services debt it is surprising that the calculator offers no suggestion to reduce the ongoing income to replace by the amount of mortgage repayments saved from the repaid debt.
- Since education is usually funded out of income a similar – but slightly different – trade-off should be envisaged for ongoing income with that number too.
- Pre-funding retirement income for a survivor is likewise going to reduce the call on their income – sometime substantially.
- I thought that a calculator should make it easier to understand, not harder. By treating these items as separate, not goals that could all be met from future income, it is easy to arrive at silly numbers.
But if you want a really silly number, try the consumer’s approach to setting their life cover amount. Unaided, when I ask them, they come up with two methods: take the home loan and divide it by two (there are usually two incomes these days). Alternatively they ask a friend how much they have and discover, more often than not, that they have about $200,000. So they buy that too. They don’t even contemplate income protection.
The real problem with this method is that in most of the bigger towns and cities in New Zealand it means that the insurance package will fail in what I think is the baseline test: do you get to keep the house? It will fail if one of the income earners is disabled (more likely) or dies.